What is Arbitrage?
It refers to the process of buying cryptocurrencies on one exchange at a low price and selling them on another exchange at a higher price. This is possible because different exchanges usually have different prices for the same cryptocurrency.
This process is possible because of the way cryptocurrencies are priced. Remember that the cryptocurrency price is dictated by the pressure between supply and demand, of those who sell coins and those who want to buy them. A dynamic supply that gradually pushes the price down or up accordingly. This is what ultimately makes this type of practice possible.
How does arbitrage work?
Understanding how arbitrage works is simple: imagine that a cryptocoin is listed with a price of 1000 $ per coin on an exchange website and at 1050 dollars on a different exchange platform.
Arbitrage is the process of buying a coin for 1000 dollars and reselling it for 1050 on the second exchange, gaining 50$ in the process.
What makes the crypto arbitrage process possible?
The arbitrage process is made possible by several factors, among which we can list the following and the most fundamental:
Liquidity and price differential between different exchanges. High liquidity for an exchange generally pushes cryptocurrency prices to maintain a high spread. This is a consequence of high demand and supply and the consequent transit of money in its various forms. Therefore, an exchange with high traffic and liquidity will generally command a better price than one with less traffic and less liquidity.
On the other hand, exchanges have a variety of users that cause prices to act in a specific way. For example, an exchange with a large number of institutional users will have a downward price differential compared to one with personal users.
Trading position also plays an important role when it comes to influencing cryptocurrency prices. In countries with higher demand for a given cryptocurrency, its price will tend to increase. This is contrary to countries where demand is low, where the price of that crypto will tend to fall.
Similarly, events within the countries where exchanges take place affect the price of cryptocurrencies. This point affects the price difference.
The union of these factors is what makes arbitrage possible in the world of cryptocurrencies.
Is arbitrage legal?
At this point, you are probably wondering: is arbitrage legal? The answer is short: Yes, arbitration is completely legal. In fact, there is nothing illegal about buying and selling cryptocurrencies on different exchanges as long as each exchange’s rules are respected.
What is the best strategy to do arbitrage?
Doing arbitrage manually could be extremely time-consuming and risky, since a lot of factors like price fluctuations, and differences in prices between exchanges have to be constantly monitored.
Also, the buy/sell operation needs to be done in the shortest time possible.
For these reasons, the best way to do arbitrage is with some automated exchange software that helps you during the whole process.
Be prepared for anything.
The trading world is extremely dynamic and cryptocurrency trading is even more so. At any time Cryptocurrency prices can fluctuate in incredible ways at any time. Therefore, keeping an eye on market signals is essential to implementing a good arbitrage strategy.